Yahoo’s Alibaba Windfall Means Firepower to Chase Google

Marissa Mayer is finally set to get a cash infusion from Yahoo! Inc. (YHOO)’s nine-year investment in Alibaba Group Holding Ltd. -- along with the pressure of putting the money to work.

Yahoo is selling 208 million shares, or about 40 percent of its Alibaba stake, in the Chinese Internet company’s upcoming initial public offering, and could generate in excess of $10 billion in the process. That would more than double Yahoo’s cash stockpile.

Mayer, almost two years into a turnaround effort that’s failed to produce much sales or profit growth, must decide how to deploy the capital. She could return cash to shareholders through a buyback or dividend, or focus on expansion through acquisitions. Choosing wisely is critical, as the payout offers Mayer her best shot yet at narrowing the ever-widening gap between Yahoo and Web rivals Google Inc. (GOOG) and Facebook Inc.

“It gives her firepower to go buy companies,” said Colin Gillis, an analyst at BGC Partners, who has the equivalent of a hold rating on Yahoo. “What she does with the cash will define how effective of a manager she is.”

Yahoo could look at purchasing public companies including AOL Inc., which may help deliver sales growth, Gillis said. Mayer may also add to her string of startup acquisitions with Web companies that can generate more visitor traffic, he said.

Sarah Meron, a spokeswoman for Yahoo, declined to comment, as did Caroline Campbell, a spokeswoman for AOL.

Alibaba Numbers

Alibaba filed yesterday for what could be the largest U.S. IPO on record, with the Hangzhou-based company set to raise as much as $20 billion, according to data compiled by Bloomberg. Analysts have estimated the company’s valuation could reach at least $150 billion at the time of the offering.

Yahoo owns 523.6 million shares, or a 23 percent stake, in Alibaba, the remaining holdings from a $1 billion investment in 2005. Shareholders of the Sunnyvale, California-based company reaped the rewards of that deal in recent years even as Yahoo’s digital-advertising market share plummeted because of the surging popularity of Alibaba’s services like the Taobao Marketplace and Tmall.com, which connect retail brands with consumers.

Alibaba’s sales jumped 57 percent in the nine months ended Dec. 31 to $6.51 billion from the same period a year earlier, the company said yesterday in its prospectus with the U.S. Securities and Exchange Commission. Net income increased by more than 300 percent to $2.85 billion. Yahoo shares have climbed 141 percent in the past two years, almost quadruple the gains in the Standard & Poor’s 500 Index.

Benefits Remain

Mayer and investors will still benefit from Alibaba’s growth, because Yahoo is keeping 60 percent of its shares. Robert Peck, an analyst at SunTrust Robinson Humphrey, said Alibaba is the most valuable piece of Yahoo, accounting for more than half the price of the stock, which he gives a $40 target. Less than $7 of it is tied to Yahoo’s main business, he said in an April 16 note to investors.

Yahoo’s stake in Alibaba is valued at $26.2 billion, based on a fair value that Alibaba assigned to its shares last month, according to the prospectus. Yahoo’s market capitalization as of yesterday was $36.7 billion.

Yahoo’s net revenue is expected to increase less than 2 percent this year to $4.5 billion, a sixth consecutive year of little or no growth. Meanwhile, the overall digital-ad market should jump 15 percent in 2014, according to EMarketer Inc., with Yahoo’s share falling to 2.5 percent from 2.9 percent.

Driving Growth

Mayer has said she’s focused on several areas to drive growth, including mobile, video and social. She also sees opportunities in native advertising, which places promotions within content like news stories, rather than placing display ads near the top of the page or alongside the content. Mayer’s biggest acquisition to date was last year’s $1.1 billion deal for blogging site Tumblr Inc., which can help with native advertising.

Yahoo showed signs of progress in the first quarter as net sales topped some analysts’ estimates and revenue expanded for the first time in more than a year. The stock jumped 6.3 percent on April 16, the day after the results, on optimism that Mayer’s efforts to lure advertisers are paying off.

“You’re seeing some green shoots of the turnaround, but they’re still very much in the middle of it,” said Peck, who has a buy rating on the stock.

The shares of Yahoo fell 6.6 percent today to $34.07 at the close in New York.

Losing Alibaba

With the Alibaba IPO, Yahoo will lose some help with earnings. A smaller stake in Alibaba means less of the company’s profit will flow to Yahoo. In the first quarter, earnings in equity investments, including Alibaba’s and another stake in Yahoo! Japan, contributed $301 million.

When Alibaba goes public, Yahoo’s development chief Jacqueline Reses, who had been an Alibaba director since December 2012, will resign from the Chinese company’s board.

As for using the cash from the IPO, Mayer has to balance the quest for growth with shareholder demands for payouts. Yahoo returned $3.3 billion to stakeholders in 2013 in the form of buybacks. Unlike technology companies including Apple Inc., Microsoft Corp. and Cisco Systems Inc., it doesn’t pay a dividend.

While returning cash may appease some investors, it does nothing to address the challenges posed by Facebook and Google, which are spending billions of dollars on acquisitions and growing much faster than Yahoo.

Cash Stewards

Mayer will now be able to notch new deals with the windfall, including seeking out high-profile startups that would bring healthy user traffic. Among the candidates that Yahoo might look at could be online scrapbooking service Pinterest Inc. and mobile-messaging app Snapchat Inc., Peck said.

Barry Schnitt, a spokesman for Pinterest, declined to comment, as did Mary Ritti, a spokeswoman for Snapchat.

Mayer, speaking at an event in New York hosted by TechCrunch today, said Yahoo would be careful with its cash.

“We intend to be good stewards of the capital; we have been good stewards of the capital to date,” Mayer said, echoing comments she made last month on a call with analysts. “We know this is of critical importance to our investors -- how any proceeds are handled.”

As she approaches her two-year anniversary at Yahoo, shareholders will want to see proof of that.